Lessons from a decade of financial misfortunes

This decade has been quite fascinating to say the least. It ended with a recession at its tail quite similar to the way it had started off with. The IT bubble gave way to the real estate bubble both of which burst with equal tenacity leaving the taxpayer at the mercy of the Capitalist system. As these huge financial institutions gambled away the savings of the common man, the brunt of the losses was borne by the hapless tax payer who was left in a lose-lose situation .The cherry on the other hand was taken by the few who actually recklessly gambled away the savings of the many who diligently paid their dues to society. An insight into these financial crises gives us an understanding of what happened, how it happened and why it happened as these are a critical part of stabilizing the financial system in the long run.
The learnings from these crises are one too many but the biggest of all has been that of the importance of regulation in our financial markets. Without adequate regulation markets become susceptible to manipulation and lose their self correction mechanisms. The invisible hand remains invariably invisible.
As in the case of the recent Global financial crisis the “invincible” sector – Real Estate also revealed the mess that was underneath the massive housing market. Right from the late 1990’s to the mid 2000’s housing prices in US rose at a CAGR of 8%. The expansionary monetary policy followed by the Clinton administration led to extremely low lending rates due to which more and more people were able to afford houses thus leading to growth in the economy in general.

But this growth was temporary as the housing bubble burst sending a ripple effect throughout the financial system. Default on mortgages and foreclosures became commonplace, thus leading to a credit crunch for the banks that had lent out these subprime loans. Soon these banks went insolvent which triggered the downward spiral that engulfed the entire global financial system. Globalization of these toxic assets made this the local problem global. Thus an understanding of complex financial products requires great expertise and judgment.
During the first half of this decade American-style consumption offered a new model of economic development. The world revolved around American consumerism. During the recession the savings rate of the debt ridden economies shot up due to reduction in disposable income of these economies. This led to a further deepening of the crises while revealing the massive overcapacity of the US retail market. So while the last decade was an age of Consumerism the next one is sure to be one of the Service Economy which would emphasize human interaction more than individualistic consumption.
Another learning from these difficult times has been the impact of labour and financial markets on the economy. The inefficiencies of the labour markets lead to escalated costs on society. On the other hand capital market failures strongly affect the labour markets. The recent global recession has left the United States with approximately 8 million jobless while the global unemployment levels have reached to around 220 million. Such weakness in the job market takes a huge toll on economic and personal well-being.
We also know that not all innovation leads to a more efficient and productive economy. Financial engineering did not create products that would help ordinary citizens manage the simple risk of home ownership. Instead, innovation was directed at perfecting the exploitation of those who are less educated, and at circumventing the regulations and accounting standards that were designed to make markets more efficient and stable. As a result, financial markets, which are supposed to manage risk and allocate capital efficiently, created risk and misallocated wildly. Thus to check the excessive leverage of the last decade, stiffer capital adequacy norms need to be put in place.
In the current crisis, China, India, and certain other emerging-market countries are coping fairly well. These countries all had strong external balance sheets and ample room for fiscal maneuver before the crisis, which allowed them to apply countercyclical policies to combat external shocks. They have also nurtured industries in line with their comparative advantage, which has helped them weather the storm. In today’s competitive global marketplace, countries need to upgrade and diversify their industries continuously according to their changing environments. The focus now should be on establishing well-functioning markets that enable developing countries to fully tap their economies’ comparative advantage.
With the advent of globalization, integration and synchronization of the business cycles across the world has become a common fact. It has its pros as well as its cons. Increased financial integration can lead to a positive effect on the exports of neighbouring countries through inter-linkages between monetary policies of these nations. On the other hand we can also have demand shocks in one country severely affecting the output of another. As was the case when the demand in US declined it affected the exports of India and as well as China immensely. The developing economies need to build up their own demand levels and reduce the burden on exports to mitigate the impact of such crisis on their growing economies. Decoupling of major economies is not a viable option as the self-sustained growth can only be possible after decades of superlative growth.
All in all this decade has proven to be one of great hurdles which have taught us important lessons about the role of greed and fear in the markets. We need to take our learnings forward and make sure that the next decade can handle all the impediments that come across its path.

Economic Renaissance should take precedence over ecological imbalance

The recent financial crisis has put the great economies of the world under immense pressure to rebuild and restructure their financial structures. It demands a comprehensive strategy from all the major countries to restore the growth momentum of the earlier decade. At this stage of the economic cycle the emphasis should only be on kick starting an economic renaissance. Entangling ourselves in the hue and cry over environmental sustainability will only inhibit our efforts in restoring the economy.
We have almost half the world living at less than $2.5 a day. The main concern of these 3 billion people is food security and that can only be attained through economic growth. For poor countries ecological impact takes a back seat as human survival becomes a priority. Even for the developing countries maintaining their growth momentum involves building on their competitiveness which can be marred by environmental constraints. The pioneer in the field of sustainable development should be the rich developed countries which have the necessary resources and technological expertise to explore renewable energy resources and to utilize them efficiently. But sadly even the US, the largest economy in the world, has not ratified the Kyoto Protocol even though it is the largest contributor of greenhouse gases in the world.
We should understand that the topic here talks about giving precedence to growth aspects of the economy and is not concerned with underpinning the environmental sustainability. Both these aspects need to be considered while chalking out a successful business model. The government also needs to be proactive in its approach towards sustaining the environment. Any company which is losing out on its competitiveness due to environmental friendly policies should be provided with the required stimulus to sustain its eco friendly outlook. Giving precedence to environmental aspects without understanding the financial implications of the same can be catastrophic for any business.
The main concern of the environmentalists should not be to stall the growth process rather it should be to develop sustainable energy resources for the future generations. The focus should be on developing cost effective solutions which are competitive in the free market and do not require any subsidies for implementation. They should work towards making global energy supply more efficient while reducing consumer demand for polluting goods and promoting cleaner energy and transport technology.
Be it Kyoto or Copenhagen, there has never been a reconciliation between ecological concerns and economic growth. The current economic scenario is not potent enough to stand any further ecological restrictions. Any attempts to do so might prove to be catastrophic.